This is certainly correct for income taxes. However, variations in VAT, especially on big ticket items, encourage people to reallocate their expenditure towards times when VAT rates are low; these induced effects on the volume of spending can be large and, furthermore, impinge on spending immediately. Indeed, the Chancellor could have gone so far as to announce a cut in future VAT rates, and it would have had the effect of cooling consumer spending today.
Furthermore, your fashionable (but erroneous) dismissal of the use of fiscal policy to moderate spending in the economy on the grounds that the lags are long and variable, ignores the fact that although interest rates are easily changed, their ultimate impact on the economy is at least as uncertain in magnitude, and the lags are at least as long and variable.
In addition, increases in interest rates empirically have rather little effect on consumer spending - for every mortgage holder made worse off by Thursday's interest rate increase, there is a depositor like me who is today rejoicing in their increased interest income. Rather, the main effect is to depress companies' investment spending by raising the cost of capital, and to reduce net exports by pushing up the pound.
As a result of decisions by this, and more especially the last, government, the Bank of England is now in the unenviable position of having to try to moderate the inflationary effects of a possibly temporary boom in consumer spending, knowing that it will have to reverse its policy stance as the adverse effects of the very tight public spending plans and the high current levels of sterling begin to kick in over the next year or two.
Getting the timing on this right will be no easy matter, but it is not made easier by governments continuing to put all their eggs in one basket.
Professor CHARLES BEAN
London School of Economics and Political Science
London WC2Reuse content